Leveraged Recapitalization

A leveraged recapitalization is when an issuer turns to the debt markets to sell bonds and uses the proceeds to buy additional equity shares or distribute equity dividends to investors.

What is Leveraged Recapitalization?

A leveraged recapitalization is when a corporation issues bonds as an instrument to raise cash funds. Those funds are then used to purchase back shares that have been previously issued in an attempt to reduce the amount of equity in the company.

The term “recapitalization” comes from “capitalization,” which refers to how the company is capitalized (the “capital structure”). At issue here is simply how the assets (the left side of the balance sheet) are funded (the right side of the balance sheet).

Leveraged recapitalization is a useful financial tool that can be applied to solve a myriad of issues related to ownership. Purposes vary, but the traditional objective of leveraged recapitalization is to provide more benefit from future growth with less risk from ownership, thus the corporate shift is from less equity to more debt. A business recapitalization is much like a home equity line of credit. It allows the homeowner to retain ownership while unlocking market appreciation in the equity by employing additional debt. The same familiar principles apply to a business recapitalization when debt is employed to leverage the equity to meet business objectives or resolve ownership issues.

Objectives of Leveraged Recapitalization

The reason for applying such a strategy may be to help boost the company’s stock value in the event of a weak market or to simply take advantage of low stock prices and thereby reserve those stocks for future capital requirements, in the form of treasury stock. A key objective might be reducing personal financial exposure to the business by refinancing without guarantees or personal collateral, all the while retaining control and a meaningful ownership position.

Motivations for Leveraged Recapitalization

At the surface, a leveraged recapitalization may seem counterproductive. Turning to the debt markets to repay debt, buy company stock, or reward investors from proceeds gained by debt instead of using earned profits may be driven by a number of incentives, however. For instance, the economic environment may be that interest rates on borrowing money are low. During this type of cycle, money is thought to be cheap, and a leveraged recapitalization may be the best option.

Also, incorporating debt onto a balance sheet might introduce greater financial discretion to the company because ongoing payments must be made to debt holders consistently. Other benefits may be tax related, depending on the region in which a leveraged recapitalization occurs. By increasing debt as opposed to equity, an issuing company avoids diluting the shares of existing stockholders and also reduces the chances that majority shareholders might attempt to shake up operations somehow. Industry participants might argue that the pitfalls of using a leveraged recapitalization include limiting growth plans at a company to the here and now as opposed to taking a longer-term view.

Changes in a company’s capital structure occur following a leveraged recapitalization. This structure is a financial snapshot of the issuing company’s equity and debt mix, including long-term and short-term debt obligations in addition to common and preferred shares of stock. This synopsis is an indication of how a business finances its operations, including internal growth and expansion initiatives.

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